Warm-Up Assume the economy is in long-run equilibrium when the Fed uses expansionary monetary policy: Draw the AD-AS model Show the impact of the policy.

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Presentation transcript:

Warm-Up Assume the economy is in long-run equilibrium when the Fed uses expansionary monetary policy: Draw the AD-AS model Show the impact of the policy on the money market Show the impact of the change on the AD- AS model Show and explain the long-run adjustment on the AD-AS model.

Inflation and the Phillips Curve Chapter 32: Inflation, Disinflation and Deflation (pgs. 860-882)

Impact of Expansionary Policy Aggregate Price Level LRAS SRAS SRAS P3 P2 P1 AD AD YP Y1 Real GDP

But how long does it take? Neutrality of Money %D in MS = %D in price level D in MS has NO real impact in long-run But how long does it take?

Cost-Push Inflation Caused by shift in SRAS EXAMPLE: Oil shock in ‘70s LRAS SRAS AD

Demand-Pull Inflation Caused by shift in AD EXAMPLE: Expansionary policy LRAS SRAS AD

Creating Money to Pay Bills… Fed could “monetize” debt Results in higher prices (neutrality principle) D in value = INFLATION TAX EXAMPLE: 5% monthly inflation $1 in one month = $0.95 today

Classical Model Assumes IMMEDIATE changes Expansionary policy = higher prices (not more output) Policies run the risk of HYPERINFLATION

Hyperinflation Rapid inflation in short period EXAMPLE: Zimbabwe

Hyperinflation Steps Debt is monetized … Inflation tax moves people out of money … Increase in MS needed … Inflation moves more people… Rinse and repeat!!

Chapter 32: Inflation, Disinflation and Deflation (pages 869-882) The Phillips Curve Chapter 32: Inflation, Disinflation and Deflation (pages 869-882)

What happens to… Unemployment and prices when AD curve shifts right LRAS SRAS AD

What happens to… Unemployment and prices when AD curve shifts left LRAS SRAS AD

Short-Run Phillips Curve

Short-Run Phillips Curve Based on EXEPECTED inflation

Shifts in Short-Run Phillips Curve